What Is Trade Diversification?
Trade diversification is the process by which a business, nation, or other economic entity offers a range of different products or services, as opposed to specializing in just one. The theory is that by offering a wider range of products through trade diversification, a business can appeal to more customers and, therefore, sell more products. A cosmetics company previously specializing in women's hair products that introduces an additional line of men's products, for instance, expands its customer base by providing a more diverse range of products. Larger economic entities can also benefit significantly from trade diversification. A nation with an economy that is entirely dependent on corn, for instance, may be crippled by a poor growing season, while an economy with a variety of agricultural and manufacturing sectors could more easily survive such unfavorable conditions.
Many different factors can lead to trade diversification. A business may, for instance, become quite successful with one product and use its success to launch another product under the same brand. The development of new technology can also lead to diversification, as technological advancements often allow for the development of new products. In some cases, diversification can lead a business to further success, thereby setting the foundation for further diversification.
There are many different types of trade diversification that a business or other economic entity can attempt. In concentric diversification, for example, a company introduces new products that use similar components and technology into a new commercial area — a successful furniture company that primarily provides tables and chairs for restaurants, for instance, may begin to produce office and home furniture. Likewise, in horizontal diversification, a company introduces new products or services that users of their current products and services may find useful. Additionally, lateral diversification occurs when a business attempts to introduce a new product or service that is entirely unrelated to their current customers, products, or services.
In many cases, trade diversification can be quite risky. A business must generally spend a great deal of time, money, and market research into introducing a new product or service. Also, unless the new product is clearly better than others already on the market, the business must generally have a well-known and respected brand name in order to successfully introduce something new into a competitive market.
On a larger scale, entire nations or other large economic entities could undergo trade diversification by developing new economic sectors. This is generally good because it reduces a nation's reliance on a specific economic sector. In some cases, new technology or the use of newly found natural resources may push a nation toward trade diversification. In others, the government might offer trade incentives or impose tariffs that encourage the development of certain industries, thereby leading to diversification.
Diversification isn't just about making money. It's also about reducing risk. There are some African countries that only have one major good for trade like coffee. This means that if people stop buying coffee beans or if the price of coffee beans plummets, these countries have nothing else to fall back on.
@turquoise-- But producing goods with a comparative advantage does not mean that an economy cannot diversify. It just means that a country shouldn't bother producing something if it's very expensive or difficult to produce it.
Countries may have a comparative advantage in many goods. So I don't think that this is a barrier to diversification at all.
Businesses are one thing, but doesn't free trade encourage countries to produce few products?
As far as I know, trade encourages countries to produce whatever they have a comparative advantage in. This means that a country can produce a good more cheaply and more easily than all the other countries. This way, everyone produces what is cheap for them and sells it to others. All countries can get a variety of goods at lower cost this way.
But doesn't this also mean that countries are discouraged from diversifying trade?
Post your comments